Crowdfunding poised to grab role as VC alternative thanks to SEC revamp

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Venture capital deals have long been the preserve of extremely wealthy individuals or institutional investors. Now, however, the growth of equity crowdfunding has the potential to turn that on its head.

Crowdfunding itself isn’t new. Platforms like Kickstarter and Indiegogo for years have offered rewards in exchange for financial support. Since crowdfunding legislation was introduced in 2016, startups have been able to offer equity in exchange for retail investments—though with strict limitations on the total capital they could accept.

But that changed recently when the SEC more than quadrupled the amount startups can raise this way each year, from $1.07 million to $5 million. With the median seed round at $2.2 million this year, according to PitchBook data, startups may find crowdfunding platforms an attractive alternative to seed fundraising through traditional venture capital.

“The previous investment cap artificially constrained the market, and this will help us to put an end to that,” said Jason Best, co-founder of Crowdfund Capital Advisors and early-stage VC firm Vectr Fintech Partners. “We have a bigger target to shoot at, and now it’s not just for pre-seed investments.”

Preliminary data sourced by PitchBook shows that since January 2000, around $4 billion has been raised globally across 6,571 deals that included capital from crowdfunding campaigns. Most of this activity has come since 2014, when several jurisdictions in Europe—including the UK, where two of the country’s oldest and biggest platforms recently merged—started to introduce equity crowdfunding regulation.

Nick Tommarello, founder and CEO of San Francisco-based crowdfunding platform Wefunder, said he expects another uptick in activity as startups use crowdfunding to delay seeking capital from traditional VCs. His own firm has already seen over $30 million in deployed capital in the first half of 2020.

“[The regulation] will have a massive impact in the United States,” Tommarello said. “The US market has been a fraction of the UK, even though it is a much larger market, and mostly because the regulations were so flawed.

“Crowdfunding shouldn’t replace VC, but it will give founders more leverage to decide when it is appropriate for them to raise from VC,” he added.

Early-stage venture capital in the US has been sluggish this year, according to the Q3 2020 PitchBook-NVCA Venture Monitor. As VCs concentrated on shoring up their existing portfolios during the pandemic, the number of potentially riskier seed-stage deals took a hit, and rounds in the $1 million to $5 million bracket dropped. Through Q3, $5.7 billion has been raised across 2,300 such rounds, behind last year’s pace, when companies raised $8.75 billion across 3,540 deals.

The new SEC rules also allow for equity crowdfunding to operate through special-purpose vehicles that group investors under one entity, reducing costs and making startups more attractive to VCs by creating a cleaner cap table. Supporters say the changes will make it easier for companies to gauge market interest before selling securities.

Not everyone is comfortable with the concept of equity crowdfunding and the risks that come with it. SEC Commissioner Caroline Crenshaw, who voted against the regulation, said the new rules fail to provide adequate investor protections.

“Smaller investors often lack the money or the assets necessary to create the diverse portfolios of private companies needed to successfully withstand the inevitable losses,” she said in a statement, adding that, unlike crowdfunding investors, VCs have more understanding of risk.

Crowdfund Capital Advisors’ Best says that concerns about risk are overblown and that regulated crowdfunding platforms have a strong mechanism in place to avoid fraudulent behavior.

“There is a generic sense of fear about fraud and schemes and unsuspecting grandmas losing their life savings, but no platform in the US wants to have an offering blow up,” said Best, who explained the platform’s main customers are not the companies, but the investors.

He added: “An economic crisis is exactly when these kinds of opportunities are most important, and I expect a huge increase, not just for seed investment but companies looking for expansion capital.”

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